“An Investment Unlike Any Other Seen Since 1957″

Mizrahi's teasing the "next Berkshire" for his Inevitable Wealth Portfolio -- and it's a different one than last time.

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This article originally appeared on October 30, 2013. The ad promising that “Next Berkshire” is circulating again and generating more questions from our readers, so we’ve republished it here for your information. The ad is largely unchanged, and this teaser-answer article is completely unchanged. The company’s share price since the article first ran over a year ago has been up sharply, thanks in large part to a fantastic quarter from Fairfax a few weeks ago.

—-from 10/30/13—–

Promises that you’ve discovered the “next Berkshire Hathaway” or the “next Warren Buffett” will get you attention, and that’s been true for a decade or more as investors have continued to seek out the opportunity to buy that “next Berkshire” before it becomes a $100,000 stock.

And who can blame investors for looking? Putting a reasonable chunk of your savings in the hands of investing Whiz Kid Warren Buffett back in the 1960s when he was starting his partnership would have been enough to create a family fortune today — assuming, of course, that you had held that investment the whole time and not sold when Warren had a bad year, as he has had on occasion, or when you’d gained 100% or 200% or even 1,000% and lightened up your position. Not many people did that, but the few who did are endowing buildings at universities now … nice, right?

But how do you find the next Berkshire Hathaway? Well, no one is is promising to find the 30-year-old Warren Buffett … but some folks are intimating that they can find the equivalent of Berkshire Hathaway in the 1970s or 1980s or even the 1990s, when the company was smaller and the growth potential more dramatic — we’ve seen teases from newsletters over the years that pitched companies as varied as Brookfield Asset Management (BAM), Greenlight Re (GLRE), Markel (MKL), Leucadia (LUK), Loews (L), Allegheny (Y), Biglari Holdings (BH), Sears Holdings (SHLD) and White Mountains Insurance (WTM) as the “next Berkshire.”

Probably none of ‘em is, of course, since that kind of remarkable return depended on a lot of external factors as well as on the ability of Buffett to master the use of insurance leverage in equity investing, and to do so without getting much attention in the first few decades. Doesn’t mean that they are or were bad investments, of course, those are all good and probably worthy companies in one way or another, and I own a couple of them personally right now (GLRE and MKL).

But if we can’t find that $100 million company that’s going to become a $200 billion company in 30 years we at least want to find the $10 billion company that could outpace the market and become a $200 billion company, right? That’s really the promise that newsletters are pitching, not that you can buy 1960s Berkshire but perhaps that you can buy 1990 Berkshire, when it was at about $6,000 a share on its way to the current $175,000 a share.

Which would work out quite nicely, thanks very much.

I own Berkshire shares personally and have bought some fairly recently, by the way, not because I think it will generate 25X my investment in 20 years but because I think it’s better than the S&P 500 with less risk — today’s Berkshire is still a pretty good buy, with a fantastic collection of businesses, but it won’t be a growth rocket.

Which was a long preamble to get us to the point of today’s piece — that Charles Mizrahi is pitching another stock as the “next Berkshire” in selling subscriptions to his Inevitable Wealth Portfolio (~$1,200) … and no, it’s not one of those in that long list above.

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That turned out not to be a “must buy” just yet, Leucadia has bounced around a bit but is mostly flat over the last two years — so in this case, again, the old Berkshire would have been a better buy at the time than the “next Berkshire” … though if you were nimble and caught the exact bottom of Leucadia’s swoon (that was back when they were buying Jefferies, so the stock spiked down for a couple weeks) you could have just about matched the S&P500 and done almost as well as Berkshire by buying LUK.

But no, Mizrahi’s recycling the basic pitch of the ad, and using the same headline, but he’s doing it with another stock in mind — another “next Berkshire Hathaway” for your consideration. Who is it?

Well, our favorite Irregulars already know the answer because of our handy dandy “quick take” box above, but the rest of you have to sit through just a few more paragraphs of my blather first (Not an Irregular yet? “Sign up now!” he suggests shamelessly).

Clues, please!

“I’m about to reveal the details of a company that looks remarkably similar to what Berkshire Hathaway looked like 40 years ago when they were making huge double digit returns.

“For the better part of the last three decades, this company has been run by a man known as “Canada’s Warren Buffett” – and he’s used the same value-oriented strategies Buffett favors to deliver remarkable returns.

“In fact, in the 27 years since the company began in 1985, this company’s book value has grown at a compounded rate of 23% per share each year.

“And their common stock price has compounded at 19% annually.

“$10,000 invested in this stock back in 1985 would now be worth $1.1 million, not including dividends.

“Simply put…this company has delivered exceptional returns for investors. But right now – for reasons I’ll explain in a moment – you can buy its shares at a ridiculously low price.”

OK, so that will sound a little familiar to some of you — particularly the “Canada’s Warren Buffett” bit, since this particular “secret” stock has been all over the news this year … but let’s share just a few more clues from the ad to build the suspense a little:

“This company focuses on buying well-managed companies…

They buy them below their intrinsic value…

They diversify their holdings…

The stock – which has compounded its book value at a rate of 23% per year – is trading at a ridiculously cheap price…

And—most importantly—this company makes money for its investors. Lots of money.

“Right now—at this very moment—the company has a whopping total of nearly $2.9 billion in cash sitting on their balance sheet…keeping their powder dry for the next opportunity that comes their way.

“Want another reason to love this stock?

“The company’s founder puts his money where his mouth is—owning roughly 12.6% of his company’s stock.—about 95% of his net worth is in the stock.”

And we’re told that one of the main reasons it’s a better bet than Berkshire Hathaway is because it’s less than 1/8th the size of Buffett’s conglomerate — which would mean it could still be pretty big, in the $30-40 billion neighborhood (Berkshire Hathaway’s market cap is $285 billion or so at the moment).

So who is Mizrahi’s “next Berkshire Hathaway?” Thinkolator confirms that yes, this is Fairfax Financial Holdings (FFH in Toronto, FRFHF on the pink sheets), a Canadian insurance conglomerate run by Prem Watsa, who has many times been referred to as the “Canadian Warren Buffett.”

We’ve mentioned Fairfax at least once before, when it was pitched by Dan Ferris at the 12% Letter as “Canada’s 13% Income Secret” — I don’t know if Ferris still likes the stock at this price (it’s around $450 now, up about 10-15% since he teased it a couple years ago), but it is certainly still a much-discussed stock in value investing circles … and, thanks to Watsa’s bid to buy Blackberry (BBRY), it’s also generating a lot of headlines.

Blackberry would not be a make or break takeover for Fairfax, and I can’t picture Fairfax running a mobile phone and messaging company as an operating subsidiary for very long — more likely it would be either a breakup of the company that includes big patent sales or a restructuring under a private equity consortium including Fairfax as one of several investors, but anything is possible. Right now they may well be focused on simply realizing some value from what has been a money-losing investment in Blackberry so far (Fairfax owns about 10% of BBRY, reportedly at an average cost of about $17 — twice the current share price), but even if they bought the entire company at the current price it would be, at an enterprise value of under $2 billion, less than 10% of Fairfax’s portfolio.

Fairfax Financial has indeed been around since 1985, when it was founded as an insurance company by Watsa, and he has been a devotee of Warren Buffett’s “buy cheap stocks, buy quality hated or misunderstood stocks, and hold for a long time” strategy and generated returns similar to Buffett’s — compounding book value and share value at roughly 20% a year. Which doesn’t sound sexy in a newsletter tease, where we’re accustomed to seeing someone promise 500% gains in a year, but is really quite spectacular. He is still running the big picture show at Fairfax and makes the big investment decisions, like Buffett does at Berkshire Hathaway, but he’s 20 years younger than Buffett so the succession talk hasn’t come up to a large degree just yet.

Generally, Watsa is more aggressive than Buffett — seemingly more willing to take calculated risks and make large bets, which paid off spectacularly well in the financial crisis. Over the last couple years, though, he has been cautious about stock valuations and Fairfax’s investments have failed to keep up with the bull market. Fairfax owns a handful of insurance companies and reinsurance companies who account for essentially all of their cash flow and operating earnings (they also own a few oddball little businesses, not unlike the early Berkshire Hathaway), so pretty much all of their employees are spread out around the globe working for subsidiaries like OdysseyRe and Northridge, they have only 30 or so employees at corporate HQ — again, like Berkshire Hathaway.

Fairfax is also fairly hard to figure out from a quick scan of the balance sheet — they do indeed have investments and assets of more than $30 billion, but most of that is balanced by liabilities in their insurance contracts … so like any insurance company, they don’t really “own” most of their portfolio because they haven’t earned the insurance premiums they’re holding and won’t earn a big chunk of it (they’ll have to pay claims or otherwise settle contracts to cover a large portion), but while they hold that cash they get to profit from the investment returns they receive by using the cash. The market cap of the company is less than $10 billion, so in some ways you get the earnings from $2.50 of a Watsa-managed portfolio for every dollar you invest — not the actual $2.50, just the investment profit earned from that $2.50.

That’s the glory of being an insurance company, but there are also heavy costs to being an insurer so it also means you need to pretty consistently break even — or at least not lose too much money — on the insurance side of the business unless you’re really spectacular on the investing side. That’s true for all insurance companies, not just Fairfax, and Fairfax has learned that lesson the hard way with some really bad years in the past as they tried to turn around some of the insurance firms they acquired — over the last decade, though, it’s been mostly pretty good performance all around from Fairfax and Watsa, with the boom years around the financial crisis further bolstering his reputation. In recent years the stock has trailed the market largely because a chunk of the investment returns were eaten up by substantial underwriting losses, though last year the underwriting just about broke even (a combined ratio of 100 or less means you make money on underwriting, more than 100 means you’re losing money — FFH had combined ratios of 103.5% in 2010, 114.2% in 2011, and finally a profit with 99.8% in 2012).

Is it a good buy today? Well, I can’t say for sure, of course, but my guess would be it’s probably a decent buy if you’re willing to wait a few years, but it’s probably too expensive right now and it will be an interesting ride — Watsa bought an Irish bank during the financial crisis, and he was buying Greek REITs last year, so he will be genuinely contrarian and take risks in places that are probably scary to most investors but he’s not betting the company on these investments, Fairfax has a large and pretty diversified portfolio.

Most insurance companies are valued by investors based largely on book value, with bad insurers or breakeven reinsurers trading for a discount to book and great specialty insurers getting a decent premium of up to as much as 1.5 to 2X book value. FFH has over the last five years mostly been trading between 1X book and 1.2X book, and it’s right near the top of that range now even though book value has fallen so far this year and is expected, thanks to Fairfax’s very cautious equity strategy right now (they’re fully hedged, and thus haven’t enjoyed the bull market), to have fallen more still in the last quarter which will be announced in about a week and a half.

It also does pay a dividend, which is paid annually in January and has been $10 for the past two years — presumably that will continue or grow, but there’s no guarantee of that, so it might yield 2% or a bit more at current prices (the stock is near an all-time high now).

The stock has been on a tear in recent months, breaking above the range of $350-$420 or so that it had been in during the last few years of lackluster operational and investment performance — I’m not sure why, frankly, other than the fact that the Blackberry fight is getting Fairfax a lot of attention. If you want a more cautious assessment, there was a sober article about Fairfax’s headwinds in the Globe and Mail just yesterday.

Sound like a worthy “next Berkshire” or a buy to you? Prefer a different member of the long list of anointed “next Warren Buffetts?” Let us know with a comment below.

Disclosure: as noted above, I own shares of Greenlight Re (GLRE) and Berkshire Hathaway (BRK.B) personally, and I also have a substantial position in Markel (MKL). I won’t trade any of those or any other stock mentioned above for at least three days.

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One of my earlier stock purchases was a single share of stock in Berkshire Hathaway — by then the B shares were well over $3,000 pre split. And I started buying Markel shares and Google shares when my portfolio was much smaller, often just one or two shares at a time. Some people can’t buy even a single share of a $400 stock, to be sure, in which case it’s probably wiser to build up a core index fund position before dabbling in individual stocks, but if you like the company and would happily buy 100 shares at $4 a share you should also be happy buying one share for $400.

That’s not to say I think you should buy Fairfax — but with discount brokers making it cheap there’s no reason to be held hostage by the historical tradition of buying “round lots” of 100 shares at a time unless you’re using options (like a buy/write covered call strategy, for example).

Travis…Once again THANKS for your great insights…Dan Ferris (who I enjoy following) is still high on FRFHF ; first recomended 2009 and holding, and the lastest write-up 8/2013 with a buy up to price of $430….

I held Fairfax for over 2 years, at a time when it did not budge from about $400/share. I bought on the advice of Ferris’ predecessor for the same publication, Tom Dyson. Shortly after Ferris took over from Dyson he echoed the Fairfax recommendation. I continued to hold. Then I read that Watsa’s philosophy was to expect deflation and invest accordingly. So I sold. I was hoping to say Whassup Watsa? but now it’s too late, and I’m not going back in this water.

I am a Canadian and have followed Fairfax for many years but do not own shares at this time!
They have gone through lots of turbulence over the years and were successful in winning a lawsuit against a U.S. analyst who wrote negative comments and alleged their loss reserves were inadequate and understated ! Apparently the analyst had connections to short sellers of the stock !
Recently , Fairfax invested in a Canadian retailer ” Reitmans” and this seems very questionable but perhaps there is some value as we will have to wait and see the
outcome of Blackberry and Reitmans ! Prem Watsa has a very solid reputation as
an astute investor and businessman in Canada but seems to be branching out as a
conglomerate and his core business was always general insurance !

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Author/Editor: Charles Mizrahi

Publisher: Eastman Communications

Covers long list of “great companies selling at a discount,” recommends a value stock portfolio, and profiles one “bulletproof business” each month. ——————-advertisement—————– Exclusive invitation: Our friends at Elliott Wave International have just released their new 53-page independent investor report, The State of the Global Markets — 2015 Edition: The Most Important Investment Report You’ll […]

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